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Differentiate between fixed cost and variable cost

Fixed costs are cost that will remain same in total regardless of changes in activity level.
Fixed cost does not fluctuate with changes in the level of activity. Since fixed cost does not
change with the level of activity, as volume increases, unit cost declines

Variable costs are cost that will change in direct proposition to the changes in the level of
activity. Variable cost per unit does not change and it will remain constant at any level of
activity. When there is no activity the variable cost will be zero unlike the fixed cost

In the given scenario the costs are classified according to its behavior and nature as illustrated
below

Description Cost Behavior Cost Classification


Electricity cost per unit of production Variable Cost Direct Expense
Telephone cost per unit of production Variable Cost Direct Expense
Labor cost per unit of production Variable Cost Direct Labor Cost
Rent expenses per month Fixed Cost Indirect Expense/ Production Overhead

Electricity cost per unit of production, Telephone cost per unit of production and Labor cost per
unit of production: These costs will be considered as direct expense of producing a fish product
as this is directly identifiable costs with the unit produced. Further these costs will directly or
proportionately will increase as the activity level increase, therefore these will be considered
as variable costs.

Rent expense per month: This is considered to be indirect expense or production over head as
this cannot be directly identifiable with the unit produced. This is a fixed cost as this cost will
remain constant and does not vary according to the activity level.

Total Cost

Total production cost of a unit will be calculate as

Total cost (TC) = Fixed Cost (FC) + (Variable cost per Unit (VC) X No of unit produced).
According to the scenario the total cost per unit will be calculated as below
Description MRF
Electricity cost per unit of production 15
Telephone cost per unit of production 20
Labor cost per unit of production 80
Total Variable Cost 115
Total Fixed Cost 20000
Total Unit Cost 20115

Assumed if the company produced 1000 units of fish production the total cost of the
production will be calculated as

TC = FC + (VC X No of unit produced)

TC = 20,000 + (115 X 1000)

TC = 20,000 + 115,000

Therefore TC = 135,000

If the company produces 1000 units, the production cost as estimated as MRF 135,000

Breakeven point

Break-even point is the volume of sales required in a period to break eve and make neither a
profit nor a loss. Management might wanted to know what the break-even of a project for
following reasons

1. Assess the probability of avoiding a loss


2. Identify the minimum volume of sales that must be achieved to avoid a loss
3. To assess the risk of the budget through comparing the budgeted sales with the break
even units
4. To decide the margin of safety

Therefore break-even point could be considered as where profit will be zero. If the profit is
MRF 0, total contribution is exactly equals to total fixed cost

Contribution = Selling price per unit Variable price per unit.

According to the sum the contribution per unit will be


Contribution = 140 115

Contribution = MRF 25

Break-even calculated as

Break-even Point = Total Fixed cost/Contribution per unit

Break-even units = 20,000/25

Therefore, Break-even units = 800 units

Break-even sales revenue = 800 units X 140 = MRF 112,000

Total revenue and total cost analysis at 800 units of production

Description Unit/MRF 800 Units

Electricity cost per unit of production 15 (12,000)

Telephone cost per unit of production 20 (16,000)

Labor cost per unit of production 80 (64,000)

Total Variable Cost (92,000 )

Total Fixed Cost (20,000)

Total Production Cost (112,000)

Total Sales Revenue 140 112,000

Profit/Loss 0

Break-even analysis does the following assumption when calculating break-even point

1. Production equals to sales


2. Fixed costs same in total and unit variable costs same at all level of output
3. Can only apply to one product or constant mix
4. Sales prices constant at all level of activity

Break-even diagram
This is call breakeven chart and it clearly describes the relationship of total cost and total
sales revenue and the point both total cost and total sales revenue meets called breakeven
point. Further all the other costs are clearly defined as fixed cost and variable cost.

Contribution Diagram

The main difference between breakeven chart and contribution chart is breakeven chart uses
fixed cost line to define the variable cost, but contribution chart uses variable cost line to
define the fixed cost.

The common feature of both the diagram is that both the diagrams use total sales revenue line
and total cost line to determine the breakeven point.
Both the diagram clearly defines that total variable cost and total sales revenue starts with
zero point as there will be no cost or revenue incur at zero level activity and cost and the
revenue start change directly or proportionately in response to the change of level of activity.
Whereas fixed cost line stay constant regardless of change of activity. Total cost line starts at
the point of fixed cost as this is the combination of variable cost and fixed cost. The point
where total cost and total sales revenue meets called breakeven point, where company makes
no profit and no sales.

Factors Impacting the Demand

1. Preference of the Consumer


It is a very important factor to consider which impacts the demand of a product.
Greater the preference of the consumer grater the demand for the product, but
consumer preference often changes for various goods therefore demand for the
product change according to the consumers preference. The preference of the product
often changes due to changes in the fashion and the advertisement pressure of the
manufactures over the consumer

2. Changes in Prices to the Alternative/Related Product


The demand of the product is also affect by the price of other product, especially
product which is closely related to the product. Therefore when the prices of
substitute product change, the whole demand curve of the product change its position.
For example tea and coffee are close substitute. When coffee price declines, the
demand for tea will decline as a result.

3. Expectation of Consumers
Customers expectation on price directly impacts the demand of the product. If the
consumer feels that future price of the product will drop they will wait for a future
date to purchase it as a result it will impact the current demand. If the prices are
expected to rise in the future, consumer will start purchase now as a result it will
impact the current demand of the product. Car, house, gold and etc. are good example
for such demands.

4. Change in Population
As population increase the demand too increases as well because the needs of the
population should be met, for example education, housing, medical and etc. However
this needs change over the time as segment of population change over the age as their
needs also change.

5. Advertisement
Advertisement has a great influence over the consumer to create the demand of the
product. The purpose of the advertisement is to create a favorable influence over the
consumer to increase the demand for the product. When advertisement is success, it
will increase the demand of the product.

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